Gold, as a precious metal, offers a potentially high return. In addition, it provides a degree of psychological security matched by a few other investments. There has been a demand for gold due to its utility for scientific and industrial purposes. Gold has been held by individuals over a very long period and has proven to be a relatively safe and stable investment.
Demand for gold is global. Despite the perception that gold is a luxury good bought for jewelry and investment purposes by developed and developing nations, over 50% of demand comes from emerging markets
Gold is tangible and can be purchased in relatively small quantities and in various forms. There are several ways to invest in gold:
- Investment in physical gold: jewelry, bars, or bullion coins.
- Buying Gold ETFs and Mutual Funds.
- Investing in Shares of Gold Mining Companies.
- Buying Gold-Backed Securities, e.g., Sovereign Gold Bonds.
- Investment in Digital Gold.
- Trading in Gold Futures and Options.
Features of Gold
Some of the essential features of gold as an investment are:
- It has delivered superior absolute and risk-adjusted returns to other commodities over time.
- It is a more effective diversifier than other commodities.
- It outperforms commodities in low inflation periods.
- It has lower volatility.
- It is a proven store of value.
- It is highly liquid.
Investing in Physical Gold
The ownership of gold jewelry has a substantial disadvantage as the acquisition costs are incredibly high because jewelry is often marked up by manufacturing costs in a range of 10-50% or even more in retail shops. In addition, all jewelry pieces are different, and their values are subjective. The real value of jewelry is in the gemstones, the design, and the craftsmanship. These greatly outrank the value of the gold.
The advantage of physically owning the metal as bullion coins or small bars is the liquid market for buying and selling them. In addition, it is comparatively easy to find buyers or sellers for gold. Therefore, coins and small bars could be an appropriate gold investment method, especially for people whose view is long-term and for whom physical possession is the main objective. The disadvantage is the significant difference between the buying and the selling price, which is 5-10% or could be even more. Moreover, there are considerable storage costs. The overall costs for dealing, delivery, storage, and insurance can add up to 10-15%.
Investing in Non-Physical Gold
An alternative means of investing is to buy a gold-based mutual fund or exchange-traded fund (ETF). Value of an ETF and a Mutual Fund unit track the importance of physical gold with slight differences. Investment in Gold ETFs and Mutual Funds is a passive form of investing in gold.
One can invest in stocks of gold mining companies also. However, the value of these companies may not always directly correlate with the value of gold itself and may be subject to influences unlinked to the price of gold. For instance, if a mining company is affected by an industrial accident, its stock could fall dramatically even if gold prices go up.
Another way of getting direct exposure to gold without physically owning it is to buy a gold certificate. Currently, the gold certificates are issued by the company backing them. So there should be an equal amount of gold supporting the certificates as the company claims. The problem is that those certificates are not representing the gold; they are as reliable as the company backing them. So investing in gold certificates is not the same as buying physical gold. However, investment in gold certificates issued by a government brings an element of safety and liquidity, e.g., GOI Sovereign Gold Bonds.
Advantages of investing in gold in the non-physical form are:-
- Ease of buying and selling,
- No requirement for storage, and
- It could be liquidated without loss of value.
Investing in Digital Gold
In the blockchain era, digital gold has emerged as an opportunity to invest directly in gold while avoiding many challenges of owning physical gold. Digital gold is essentially a blockchain-based digital token technologically similar to Bitcoin. Still, unlike Bitcoin, the ticket is backed by a real-world value, the equivalent amount of physical actual gold reserves.
In this way, the owner of digital gold doesn’t need to take custody of their investment because it’s held in a vault by the token issuer. This makes digital gold cheaper to handle than physical gold, plus the owner doesn’t have the headache of organizing storage and insurance.
Advantages of Digital Gold
- Anytime entry and exit options.
- Option to get delivery in physical form.
- You can invest with a smaller amount of SIP, e.g., in 1 gm of gold per month.
Disadvantages of Digital Gold
- Not a regulated product.
- Intermediary costs and taxes make it expensive comparatively.
Gold Futures
Futures contracts, as the name implies, provide for the future delivery of a specific commodity or another instrument. For example, a gold futures contract could be of 1gm or 1Kg. It depends on the exchange’s offerings of gold futures contracts. Further, gold futures have a range of contract dates, including monthly, for the next two months, and even longer.
A futures contract buyer locks in the right to buy gold at the current contract price, and a seller locks in the same price to deliver the gold on the contract date. Traders, who have no interest in actually buying or selling gold, can buy and sell futures contracts to profit from the changing price of the metal. A futures trade could be closed or rolled to a future gold futures contract to avoid delivery.
If the futures contract goes your way and gold performs well and goes up, then you pay the agreed-upon price on the delivery date specified in the contract, and in exchange, you receive gold, which is worth more today than its price when you made the futures contract. This is speculation. You can speculate if you believe the price of gold will go up and also if you think the price will go down. In the former, you are going “long,” and in the latter, you are going “short.” You can sell a gold futures contract if you believe gold will correct sharply. By trading gold futures, you agree to sell gold in the future for a price agreed now. If the price of gold falls, then you will gain.
It is important to note that futures contracts are obligatory for both parties.
Gold Options
Gold options are purchased as an alternative to gold futures. These contracts do not oblige their purchasers but merely give them a right depending on the type of contract they enter. By buying a gold option, one gets an additional power of choice, giving extra leverage.
Buying Options requires payment of a premium. It’s just like paying a premium for an insurance cover. However, the premium paid on Options may go wasted if an advantage on the Options couldn’t be taken.
Gold Options trading is done through calls and puts. A call option is mainly acquired by traders who believe that prices of gold futures are on the rise. On the opposite side of calls are puts purchased by bearish traders expecting that prices of gold futures will go down.
You can not only buy options; you can also sell them, as many traders do regularly. Options selling is one of the significant gold options trading strategies. The main objective behind this strategy is to sell your options hoping that they expire unrealized and you can gain profits.
Calls and puts are two major gold options trading strategies. However, there are some more advanced trading strategies used by more experienced traders.
Leverage Buying
Trading in futures provides leverage, also known as gearing.
For example, you have Rs 50,000 to invest. But, if you buy gold bullion and settle, you can only buy approx.—10 grams of gold. But you can probably take a position in 100 grams of Gold Futures worth Rs 5 lakhs. That’s because a margin on Rs 5 Lakhs worth of Gold Futures would need around 10%, i.e., Rs 50,000.
If the underlying price goes up by 10%, you will make Rs 5,000 from bullion, but Gold Futures of Rs 5 Lakhs would generate a return of Rs 50,000.
Sounds good, but don’t forget the flip side. If the price of gold falls by 10%, you’ll lose just Rs 5,000 with bullion, and your investment would be intact to earn you money if gold resumes its steady upward trend.
But the same 10% fall will cost you entire Rs 50,000 with Gold Futures, which is Rs 45,000 more than you invested in the bullion. This loss may force you to close your position in Gold Futures, so your money is lost.
You can see why Futures could be dangerous for people who get carried away with their own emotions. The large majority of people who trade futures lose their money. That’s a fact. They lose even when they are right in the medium term because Futures are fatal to your wealth on an unpredicted and temporary price blip.
Conclusion: Gold is for Everyone and Provides Investment Diversification
Gold is one of the most sought-after commodities when diversifying an investment portfolio. It could be held in both physical form and derivatives. In physical form, although it may require outright investment but provides a sense of satisfaction and pride. When held in the form of derivatives, it may give leveraged returns. In addition, gold is less correlated with other investment assets like equity, fixed income instruments, etc. As a result, its value is expected to rise during economic growth and slowdown.
Gold is a precious metal that has allured humans for centuries. It doesn’t make any differentiation between rich and poor and amongst nations. Both urban and rural populations are fond of gold. Recent developments have only changed the ways it is held.
